The advantages of a preferred stock strategy

By Robert Stepleman

Monday

May 30, 2016 at 2:00 AM

As regular readers know, the one type of annuity I believe worth considering for some retirees is a single premium immediate annuity. But I recently read a study that suggested a strategy using preferred stocks that might be suitable for some retirees and could provide them both higher payments and other benefits, but with some additional risk.

A SPIA is a contract between the buyer and an insurance company. The buyer gives the insurance company a lump-sum premium and the insurance company promises to, for example, immediately begin providing periodic fixed dollar payments for a set period of time, commonly monthly over the client’s or the client’s and spouse’s lifetimes.

Here, we only consider the simplest SPIAs, one that pays over a client’s and his spouse’s lifetimes and stops when both die, but doesn’t reduce the payment after the first dies. Many insurance companies offer, at additional cost, added benefits.

Preferred stocks look like common stocks because they pay dividends as opposed to interest and provide the holder with company ownership. They look like bonds because, unlike common stocks, the dividends of most preferred stocks are fixed. Additionally, if the company enters bankruptcy, the preferred stockholder gets paid before the common stockholder. They also receive dividends before common stockholders.

Unfortunately, many preferred stocks are “callable.” This means the company can force the preferred stockholder to sell the stock after a specified date at a predetermined price. Some pay “cumulative” dividends. This means if a dividend is skipped, it must eventually be paid.

Like bonds, preferred stocks are rated by Standard and Poor’s and Moody’s. Many are below investment-grade; that is rated lower than BBB-. But if bonds of the same company are investment-grade, it’s likely not a serious issue.

Let’s look one example of how an SPIA versus a preferred stock strategy works.

Recently, at www.immediateannuities.com a 65-year-old man with a 61-year-old spouse could get an estimated (non-inflation protected) monthly income of $449 for a $100,000 initial payment. That is $5,388 a year. This payment continues until both die and then ends, leaving nothing for heirs.

Recently, according to the “Preferred Stock Channel,” the average yield of the preferred stocks they follow was 6.15 percent. However, if the portfolio is mixed between carefully selected investment-grade and other preferred stocks, then a yield of about 6.25 percent is achievable. Thus, a $100,000 portfolio of 20 or so preferred stocks would provide $6,250 of income or about $862 (16 percent) more annual income. This additional income could be spent or preferably reinvested to provide limited inflation protection.

What are the pros and cons?

The SPIA is a simple, one-decision endeavor. Its only risk is bankruptcy of the insurance firm. This is minimal, and some states offer additional protection should this occur. However, it’s illiquid. Once it’s purchased the money is no longer available.

The PSS is more complex. In addition to selecting the initial preferred stocks, the retiree will have to replace them if they are called or mature. In difficult economic times, it’s possible one or more might not pay a dividend for some time or in the worst case go bankrupt. However, diversification and careful selection can partially mitigate these risks. As well as the higher income and limited inflation protection, there will be residual value from the portfolio to the heirs as opposed to none for the SPIA. Additionally, it’s liquid.

Send comments and questions to Robert Stepleman, Business News, Herald-Tribune, 1741 Main St., Sarasota, FL 34236, or rsstepl@tampabay.rr.com. Follow him on Twitter @logicalinvestor. Stepleman is associated with Dow Wealth Management LLC as a lecturer and chief portfolio strategist. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser. Past performance is not indicative of future results. The data and performance information is for informational purposes only and is not intended as a solicitation.

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